In designing his economic policy programme for the next five years, President Hu Jintao is well advised to seek counsel from someone virtually unknown to those Chinese who came of age in the 1990s. He is Wan Li, 91 years old and still intellectually alert.

Mr Wan was a special guest at the opening session of the 17th Communist party congress in Beijing last week. It was he, more than anyone else there, who put China on the right track. In the 1980s he was a vice-premier in charge of agriculture, and before that he was the party secretary of the impoverished Anhui province.

It was in Anhui that the true Chinese miracle began. In December 1978, 18 households in Xiaogang village made a secret decision to privatise their rural output. Fearing reprisals, the households entered into a pledge – written in blood – to support the families of their leaders should they be arrested.

Mr Wan did not arrest them. On the contrary, he endorsed the experiment and bravely defended it in the face of withering attacks from conservatives. The experiment, which became known as the household responsibility system, was adopted by 90 per cent of villages in Anhui within a year and by the rest of the country a few years later.

Mr Wan was then promoted to vice-premier. In that position, he worked tirelessly to support rural financial liberalisation, lengthening the leasehold of farmland, removing employment restrictions on private businesses, deregulating rural-urban trade, curtailing the power of party officials in the countryside and introducing grassroots democracy to village governance.

The result was that rural household income per capita galloped ahead at more than 10 per cent a year in the 1980s. Western economists may tout foreign direct investment and globalisation as the reasons for China’s poverty reduction. But the true credit lies with the rural reforms. The vast majority of China’s poverty reduction came in the first half of the 1980s. Also during that period, income distribution improved.

A defining characteristic of Mr Wan and other leaders of the 1980s was that they respected the inclinations and actions of farmers rather than imposing their own visions.

The 1980s reforms were a classic example of a bottom-up, wisdom-of-the-crowd success story. A market economy, in essence, is an economic democracy. Mr Wan once told his subordinates always to assume that they were in the wrong if the farmers wanted to do something different from them.

It is truly unfortunate that China in the 1990s deviated from these market-conforming policy principles. In the 1990s, rural China was starved of financial resources in order to support industrial development in the cities. The effect of the urban policy bias was dramatic. Rural income growth collapsed from double-digit annual increases in the 1980s to about 4 per cent a year in the 1990s. Since then, under the leadership of Mr Hu, it has recovered to 6 per cent.

China will succeed or fail not because of how many skyscrapers Beijing and Shanghai have but as a result of the economic fortunes of its vast countryside. Domestic consumption will not grow if rural incomes do not improve and if rural residents are forced to save for their medical and educational expenses. China will not be a true market economy if rural land rights are not secure and if its financial system does not serve the most dynamic force in the economy – innovative rural entrepreneurs.

It may be counter-intuitive to think that China’s high-technology future depends on its countryside – but not if you believe in market principles. The success of low-tech businesses in rural China will force urban companies to innovate in their production and technology to maintain their competitive edge. The rural stagnation of the 1990s sent millions of migrants to the cities in search of jobs. Urban companies, never short of labour, were flooded with tens of millions of eager job-seekers and they did what any rational owners and managers would do in similar circumstances – they favoured labour-intensive production at the expense of research and development.

There are other long-term costs, including the fact that the children of these rural migrants failed at schools. Due to the massive policy mistakes in the 1990s, China may have produced another uneducated generation.

In the past five years, Mr Hu has formulated many worthy objectives, such as creating a harmonious society and raising the living standards of average people above gross domestic product growth. He will realise these objectives more effectively if he can listen to Mr Wan and his colleagues, such as Tian Jiyun and Du Rensheng. These visionary leaders from the 1980s, who were marginalised in the following decade, were founders of the economic miracle. Its future success depends on how quickly and completely China returns to the model of the 1980s.

The writer, from MIT Sloan School of Management, is author of ‘Capitalism with Chinese Characteristics’ (Cambridge University Press, 2008)

When Jiang Yu, a Chinese foreign ministry spokeswoman, addressed the issue of mounting protests in Burma on Tuesday she trotted out the standard line that China “always adopts a policy of non-interference” in the affairs of other countries.

“The stability of [Burma] serves the interest of [Burma] itself and the interests of the international community,” she said.

But the emphasis on “stability” and the benefits to the global community of a peaceful and prosperous Burma – a country in which Beijing has significant economic interests – underlined China’s frustration at the inability of the governing junta to broaden its popular support in recent years.

Privately, in talks with the US, and publicly in recent weeks, although less explicitly, China has urged Burma to engage the now-detained Nobel laureate, Aung San Suu Kyi, directly in recognition of her democratic mandate.

China hosted direct talks between the US and top Burmese officials in June in Beijing, in an effort to draw Rangoon back into the international community.

In September, Tang Jiaxuan, a former foreign minister who has been used as an envoy by Beijing, told Burmese leaders that “China wholeheartedly hopes that [Burma] will push forward a democracy process that is appropriate for the country”.

Xinhua, the official news agency, added that China, “as a friendly neighbour, sincerely hopes [Burma] will restore internal stability as soon as possible, properly handle issues and actively promote national reconciliation”.

China fears that any violent crackdown on peaceful demonstrators by the junta will reflect badly on Beijing itself and its willingness to support dictatorial regimes.

China has invested heavily in Burmese gas fields, often in competition with India. It is also building a port at Kyauk Phyu, in Burma, which will be connected by a 1,950km highway with Kunming, capital of China’s Yunnan province.

China’s frustration at the incompetence of the regime was in evidence in an unusually frank posting on the foreign ministry website in May.

In the posting, since taken down, a Chinese diplomat described in mocking tones the transfer of the Burmese capital from Rangoon to a specially constructed city in the isolated centre of the country.

He recounted how foreign diplomats were kept in the dark “as is usual in Burma” until they were ordered to relocate to the new capital built on a “wasteland” and renamed to make it sound grander.

“It is hard for such a backward developing country to build a large city with proper facilities from scratch,” the article said.

The article noted that after years of effort, the new capital’s basic infrastructure was barely finished and that it lacked a proper airport but that the junta had managed to complete the construction of four golf courses.

The Indian microfinance sector is starting to attract private equity groups and hedge funds after a series of high-profile deals cast the sector in a different light from its charitable origins.

Leading Indian microfinance groups, such as SKS Microfinance, Share, Spandana and Basix, make small loans of typically less than $100 to the poor and, until a few years ago, were largely viewed as a destination for charitable donations rather than serious investment.

However, this week, Indian and foreign investors interested in investing in the fast-growing sector have met about 40 microfinance institutions at an inaugural microfinance investment fair in New Delhi.

Private equity investors’ entry into the field follows that of big banks such as ICICI of India, ABN Amro, Standard Chartered and Citibank, which have in recent years greatly increased the capital they give to microfinance institutions.

The heightened interest in India, one of the largest microfinance markets, comes after a flurry of deals, which included Sequoia, the Silicon Valley venture capital company that backed Google, investing $11.5m in SKS Microfinance this spring.

“There is huge commercial interest in the sector,” said Vikram Akula, SKS chief executive. SKS has been approached by about 20 private equity funds and even hedge funds, he added.

The number of microfinance borrowers in India reached 36.8m, according to a report from the Ford Foundation, the Swiss agency for development and microfinance advisory access. Outstanding loans distributed by Indian microfinance institutions increased 76 per cent to about $766m in 2006-2007. Repayment rates of about 98 per cent have created confidence in the business.

Dubai-based Legatum Capital this week announced it would pay $8.4m for a minority share in Intellecap, an Indian adviser that focuses on microfinance.

Legatum this spring paid $25m for a majority stake in Share, as well as $4.5m for an undisclosed interest in Fino, maker of microfinance technology, such as Smart cards and card readers.

Legatum hoped that its investments would “send a powerful signal to other equity investors that the microfinance industry is worth looking at”, said Mark Stoleson, the president.

US-based Unitus Equity Fund (UEF), whose partners include the investment company of Ebay founder Pierre Omidyar, invested $500,000 in SKS last year and this year closed a $23.4m fund devoted to microfinance in Asia and Latin America.

Chris Brookfield, UEF director, said the fund would be making more investments in India soon.

Sequoia will focus on its investment in SKS but anticipates others will enter the fray. “It may not be us but you will see a lot more investors coming in,” said Sumir Chadha, managing director of Sequoia Capital India.

But he warned: “Now there is so much euphoria around microfinance, many companies expecting overnight success will probably be disappointed if they have these expectations.”

Apart from India’s biggest leading microfinance companies, many fledgling groups lack the experience to prepare for investment, said Vipin Sharma, chief executive of Access, a sector ad­viser formerly part of humanitarian organisation Care. Access has been working with small microfinance companies to develop business plans and help woo investors at Thursday’s conference. But the possible entry of private equity players has raised questions about how this could alter microfinance’s original mission of uplifting the poor.

Vijay Mahajan, chairman of Basix, pointed out that this year’s flotation of Mexican microfinance group Compartamos had made its founders millionaires. “Presumably, this will attract more capital, but on what terms to the ultimate users? Is this what we set up this sector for?” he told the magazine Microfinance Insights.

China’s stock market is trading at 50-60 times earnings – we really don’t know the number – and its residential properties are selling for 15-20 times average household income. Many draw parallels between China now and Japan of 1989 or Hong Kong of 1997. The comparison is wrong.

China’s urban residential properties and listed shares in the local and foreign stock market are worth 3.5 times GDP. Both Japan and Hong Kong peaked near 10 before bursting. I am not denying that China’s asset market is a bubble. Most blame excess liquidity for the bubble. Yes, China’s current account surplus is likely to reach 10 per cent of GDP in 2007. Such a large sum of surplus cash can cause a bubble. But, the government control of asset supply is more to blame for the ridiculous valuation.

For example, all the shares of Chinese companies listed in Shanghai, Shenzhen and Hong Kong are worth Rmb35,000bn ($4,649bn) to Rmb40,000bn, or 146 to 167 per cent of GDP. Over two-thirds of these are owned by government entities. The shares that are liquid and locally listed are merely Rmb9,000bn, or 38 per cent of GDP. China’s stock market is similar to Nasdaq’s in 2000 when the hot internet companies had ridiculous valuations but small free floats.

In addition to the illiquidity of state-owned shares, tight control over IPOs and share placements are also to blame. The controlling shareholders of privately owned and listed companies cannot sell down their shares even when they think the shares overvalued. Government policy in China deliberately blocks such arbitrages that prevent a market from running away from fundamentals.

The value of residential properties is 4-4.5 times that of the shares that households own. With investment in property construction reaching 10 per cent of GDP, it is a large market in stock and flow. Its high price is due to the presence of extraordinarily large grey income in China – earnings garnered by charging above official prices. Property construction costs less than third of the sales value. The rest goes to local governments as land sale proceeds and taxes and to property developers as profits. That money tends to circulate among people who have grey income. The higher the property price, the more the grey income.

State ownership in important sectors also generates large grey income. One developer in a second-tier city, when I asked, told me that most buyers at his vast development were teachers, doctors, civil servants and policemen. Teachers get paid by the parents of their pupils for extra care. Doctors raise prices right before putting you on the operating table. Well, civil servants and policemen . . . 

China’s property market is like a squeegee machine on the economy – all its juice is sucked out through all the levers of power and squirted into property. The high monetary value of power and the love of property have combined to make China’s property market large and expensive. Still, the value of China’s residential properties is 1.7 times GDP. Japan’s was 4.5 in 1989 and Hong Kong’s 7.5 in 1997.

China’s asset bubble may burst next week or next year. Your guess is as good as mine. The economic impact, however, will be limited. If the stock market drops by half, households lose 20 per cent of GDP in paper wealth, similar to the impact of a 15 per cent drop of the US market on its economy. If the property market drops 30 per cent, most people in China will laugh; only the rich and powerful will grumble. The banks may suffer bad debts. But the Chinese government has a tendency to pick up the tab after a party and gets another one going right afterwards. It still has the money to do so.

China’s growth drivers are trade and urbanisation. A US recession could slow down the former. But China’s trade with other developing countries is booming. As all developing countries have excess forex reserves, they can continue to spend in spite of a US downturn. Local governments drive urbanisation. They have just got their new party secretaries who are eager to push ahead. China will continue to build until it runs out of money. The banks have too much money for the foreseeable future.

Burst or not, China’s high growth is likely to continue.

Beijing's hard-pressed commuters should count themselves blessed, for they are about to receive that rarest of boons: more transport for less money.

Even as the Chinese capital opens its new 27.6km No. 5 mass transit line on Sunday, the price of tickets for the expanded underground network is being slashed to a flat fare of Rmb2, less than half the previous maximum tariff.

The opening of the Rmb12bn ($1.6bn, €1.1bn) line and the ticket price-cut highlight Beijing's belated re-embrace of public transport as the only way to ensure the fast-expanding city can function effectively.

“We are going to strongly push development of the subway in order to deal with Beijing's traffic,” says Liu Qi, the capital’s powerful Communist party secretary. “The large-scale subway development . . . may well result in the world’s biggest network.” Beijing's building plan is part of a nationwide explosion of interest in mass transit networks as urban populations are swelled by a vast influx of new residents from their rural hinterlands.

Over the next decade or so, 15 Chinese cities are expected to spend Rmb620bn to build 1,700km of underground lines and urban light railways, state media say. More than 20 other cities are also seeking permission to build lines.

Beijing is leading the way, with plans to have 561km of subway line in operation by 2015 – well above the London Underground’s 408km.

While Beijing favours Chinese suppliers, the subway surge is a big opportunity for global transit systems producers such as Germany's Siemens, France’s Alstom and Bombardier, the Canadian company responsible for a light rail link to the capital's airport that will open next year.

Beijing’s subway line plans are something of a return to the future for the capital, which was China's underground pioneer when it opened its first line in 1969.

“The Beijing [underground] was hardly late in taking its first steps, but development has come in phases because of shortages of finance and other limiting factors,” says Jia Peng, spokesman for Beijing Mass Transit Railway Operation Corp.

Perhaps the most important limiting factor has been the capital’s love affair with road transport and the car. Planners have focused largely on widening cross-town avenues and on encircling the city with multi-lane ring roads.

The rapid road construction continues, but capacity is still failing to keep up with a flood of new vehicles, with many of the capital’s more than 3m cars already spending much of their time stuck in traffic.

Municipal leaders expect to have to ban half the capital’s cars on alternate days to ensure smooth traffic when it hosts the Olympic Games in August.

Merely building the new underground lines will be no panacea for Beijing’s transport problems. The clearing of much of the city centre of its original residents means commutes are growing ever longer. And the capital still lacks the convenient suburban rail links that round out the transit systems of London or Tokyo.

Despite the cheaper fares, many commuters may still be loath to take to the underground, which is often cramped and hot and which suffers from poorly laid out stations and connections.

Such reluctance may be eased by a Rmb4bn plan to upgrade the oldest two lines with new carriages and more frequent trains ahead of the Olympic Games.

With sophisticated air-conditioning, elevators and platform safety doors, the new north-south No 5 line certainly offers a new level of mass transit comfort for the city.

Operators are even promising seamless mobile phone connections for travellers between its 23 stations as well as live TV broadcasts of Olympic events next year. For those commuters eager not to miss a minute of the games, that will no doubt seem a blessing indeed.

China’s pioneering US bank acquisition ticks all the right boxes. Minsheng Bank has gained a US presence in a business it knows well: its target, UCBH Holdings, is a San Francisco-based community bank serving Chinese family businesses. Better still, Minsheng has (so far) avoided both paying a hefty premium and ruffling feathers on Capitol Hill – a rare feat for a Chinese acquirer beating a path to the US.

All told, Minsheng will pay about $200m for 9.9 per cent of San Francisco- based UCBH in two phases. The initial 4.9 per cent bite is priced at the previous 90-day average closing price; the second may command a slim premium. That is pocket change for Minsheng. UCBH is roughly one-tenth its size in terms of assets, and the first cheque will have little impact on the Chinese lender’s healthy capital adequacy ratio. Should any strains appear later – subject to approvals, Minsheng has the option to increase its stake to 20 per cent – the lender can tap two of the world’s more buoyant capital markets. Minsheng’s Shanghai-listed shares have almost doubled this year, in spite of a massive block sale in March, and it is mulling a listing in Hong Kong.

Has Minsheng blazed a trail for peers to follow? Do not hold your breath. Unlike most rivals, it is privately owned and was ready to settle for a minority stake. That may have soothed US regulators, who are more likely to bridle at advances by state-controlled entities. UCBH is also a special case. Its need for cash meant it was prepared to sell the initial slug of stock at market price. Ironically, the cash raised will soon return to China, to fund UCBH’s purchase of Shanghai-based Business Development Bank. The whiff of reciprocity doubtless pleased the Americans. Beijing, which sees overseas acquisitions as a way to balance the waves of foreign money entering China, may have a different view.

The recent housing green paper committed Britain to building 3m homes by 2020. Where should we build them? We could scatter them across the country in line with current population patterns, but both spatial economics and history tell us that we can do better. National income will be higher if we build them in the right places.

The 19th century saw coal-producing areas and the North West become prosperous. Liverpool and Manchester, for example, proved to be perfect locations for the then highly skilled, high-wage cotton industry and grew by more than half a million people apiece. Other big towns appeared from nowhere: Crewe was a village of 46 houses and 289 residents in 1800, but a big town a century later. People were attracted by the jobs and wages on offer and Britain would have been a lot poorer without people migrating internally.

Since 1945 Britain’s prosperity has moved south-east. Today Heathrow, not Liverpool, offers the best connections to the US. We trade more with Europe, so the South East, not the North West, is the best location for many businesses. As the home of finance rather than textiles, London has simply been luckier than Manchester.

City size matters even more than in the past. Service sector companies, especially those employing highly skilled workers, gain most from locating close to each other, as knowledge spill-overs between workers and companies make them more effective. In addition the rise of dual-career, dual-industry couples wanting to work in the same city as each other gives companies in different industries the incentive to locate in the same place.

For these reasons we would expect to have seen large-scale migration to the South East since 1945, with some small towns in that area growing dramatically, as in the 19th century. But we have not. Two obvious places where we could imagine knowledge spill-overs being important – Oxford and Cambridge – have seen population grow at just 0.5 per cent per year.

The postwar planning system was based on the belief that people should stay where they were and that jobs should move to them. But the belief that we can shuffle jobs around Britain proved false. You cannot move Canary Wharf to Liverpool: it is successful (in part) because of where it is.

This mistake has real consequences, above all for those trapped in declining towns to which our planners failed to persuade companies to move. Those without qualifications in Blackburn have a one in three chance of being unemployed; the equivalent figure for Windsor is only one in five. Those in work are less well paid outside the South East. Big house price differentials caused by misguided planning policies make it hard for people to migrate towards the South East.

It is correspondingly plausible to imagine that Britain would be richer were Whitehall planners simply to divide the 3m new homes equally between Oxford, Cambridge and London. It is highly unlikely that this would generate a worse outcome than spreading them fairly evenly across Britain. But the history of planning tells us that Whitehall does not know best. Rather than trying to pick winners, we should use market signals to decide where to locate these homes.

Britain’s highest land values are currently found in London and nearby commuter towns such as Reigate; in Oxford; and in Cambridge. A hectare of land in each is worth at least £8m, or around £200,000 per property. Nowhere else comes close to matching these levels. Additional houses in these areas are worth more because these places are capable of generating additional well-paid jobs. It is clear, therefore, that these are the most sensible places to build the first of the 3m new homes.

As we do so, the increase in supply may lead prices to fall to more typical levels, in which case the price signal will automatically lead us to build in other areas. But if the new homes attract new companies, then wages in these newly enlarged cities will stay high, leading housing and land prices to remain high. If that is the case, and it seems a plausible scenario, then the sensible strategy would be to keep increasing the size of these cities, generating more and more high-quality, high-wage jobs in the process.

Oxford and Cambridge would then become the Liverpool and Manchester of the 21st century: cities whose economic success leads to dramatic expansion, to the benefit of those who move to them, and, via buoyant tax revenues, to all of us.

The writer is lecturer in economic history at the London School of Economics

Dear Economist,

I am worried that if my children receive sex education at school, it will make unwanted pregnancies more likely. Should I take them out of class?

Protective Parent

Dear Protective Parent,

You are right to be worried. It is easy to see why information about contraception might encourage sex by lowering its costs, but the effects might be more dramatic than you would think. In a nutshell, fixed costs are your problem. These are obvious when it comes to, for instance, producing software. The first copy may cost hundreds of millions of dollars to produce, the second very little. But losing your virginity is like that too: the first sexual experience comes with a psychological cost, but, once paid, future experiences are easier. (Economics students will recognise the implication: sex has economies of scale, so it is efficient to either have lots or none at all.)

Within a relationship, too, the first sexual experience probably has a fixed cost.

In both cases, access to contraceptives makes it likelier that the first experience will be chosen; having crossed that barrier, it may become so attractive to have sex that teenagers will do so even when the contraceptives are not available.

The economists Peter Arcidiacono and Ahmed Khwaja, of Duke University, with Lijing Ouyang of the US Centers for Disease Control and Prevention, believe that this is the way teenagers do, indeed, behave.

Yet, I would not advise you to shield your children from sex education. That might be wise if prevention of pregnancy and disease were your goals, but that is too extreme. Your children will know that sex has benefits as well as costs. Perhaps you should refresh your memory about these?

Questions to economist@ft.com